New rules aim to stop rerun of 2022 crisis that led to £425bn wipeout in funds linked to UK government debt
In co-ordinated statements on Monday, the Central Bank here and Luxembourg’s Commission de Surveillance du Secteur Financier introduced new rules for so-called liability-driven investment (LDI) funds denominated in sterling so that they can withstand a swing of three percentage points in the yield on UK government bonds, known as gilts.
The measures will require that sterling-denominated LDI funds authorised in Ireland can withstand sudden and adverse shocks to UK interest rates.
The move will largely affect UK pensions but is being introduced because a significant amount of those funds are managed in Ireland and Luxembourg.
The threat of a sharp move in bond yields to such investments was exposed in 2022 during the short-lived prime-ministerial career of Ms Truss and her finance minister Kwasi Kwarteng. Their “Trussenomics” mini-budget was supposed to kick-start growth by radically slashing taxes, but instead it spooked investor confidence in the UK government’s financial stability and sent bonds plunging and bond yields sharply higher.
UK pension fund values plunged by around £425bn during the market turmoil.
And the situation had threatened to become a self-sustaining crisis as falling bond prices sparked pension managers to dump them on the market, sending prices lower again.
After days of market chaos, the UK’s central bank, the Bank of England, stepped in with a massive buying programme to prop up the bonds but not before many pension schemes buckled under the strain.
The new move is targeted at sterling-denominated LDI strategies, a technique used by thousands of corporate pension schemes to manage their ability to pay out defined benefit pensions as they are drawn-down by matching investments to those liabilities.
The LDI strategies tend to invest heavily in government bonds that typically trade fairly predictably and combine that with high leverage, or debt, and more sophisticated financial instruments such as gilt repurchase agreements.
Historically it has been a fairly successful strategy but when the 2022 mini-budget sparked massive volatility it sent shock waves through the pensions structure, including forcing money managers to dump bonds as their price fell because their value as collateral for the leverage in LBI structures also dropped, a process that can rapidly become a vicious circle.
“The gilt market disruption of 2022 demonstrated how financial vulnerabilities in non-bank financial intermediation can amplify adverse shocks to the rest of the financial system and the broader economy,” said Governor of the Central Bank of Ireland, Gabriel Makhlouf.
“The macroprudential measures announced today aim to safeguard resilience of sterling LDI funds, and – in doing so – support financial stability at a global level,” he said.
As well as being backed by regulators in Ireland and Luxembourg, the new rules were endorsed by the European Securities and Markets Authority (ESMA).
There will be a three-month implementation period to allow existing LDI funds to comply with the measures and the new reporting template.
